Pound Traders See Brexit Risk Rising at the Time of EU Summit

The currency options market is betting that trade talks between the U.K. and the European Union will go down to the wire, which leaves room for outperformance of volatility gauges spread over different tenors.

Sterling’s volatility surface against both the dollar and the euro as well as risk reversals show there is little panic over immediate maturities stretching from one week to a month, but climb thereafter in time for a key European Union summit.

While the next round of talks between the two sides gets under way Monday, there is little indication either side will give way on fishing rights. The EU wants to keep the access it has to U.K. waters, while Britain wants reduced access and make it conditional on regular negotiations. If the history of Brexit negotiations is any guide, this one will go down to the wire. That would imply that, as things currently stand, the first climax will be set for Oct. 15-16.

Any failure to find a solution in time for the October meeting won’t prove fatal for the pound as the European Council meets again on December 10-11. Political posturing between the U.K. and the EU has never been in short supply in the past, and there is no reason to believe that this will suddenly change.

All of which suggest that implied volatility that stretches beyond a two-month time frame will outperform near-dated gauges.

• NOTE: Ven Ram is a currency and rates strategist for Bloomberg’s Markets Live. The observations are his own and not intended as investment advice. For more market analysis, see the MLIV blog

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